Nahhas v. Comm'r

T.C. Summary Opinion 2007-28

UNITED STATES TAX COURT

NADA NAHHAS, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3235-05S. Filed February 27, 2007.

Glenn Seiden, for petitioner.

Thomas D. Yang, for respondent.

GOLDBERG, Special Trial Judge: This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

- 2 -

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

Respondent determined a $23,860 deficiency in petitioner’s

2002 Federal income tax. Respondent also determined an addition

to tax under section 6651(a)(1) and an accuracy-related penalty

under section 6662 in the amounts of $2,386 and $4,772,

respectively.

The issues before the Court are: (1) Whether $122,200 is

includable in petitioner’s income as alimony; (2) whether

petitioner failed to report $2,317 in interest income; (3)

whether petitioner is liable for the alternative minimum tax;1

(4) whether petitioner is liable for the addition to tax under

section 6651(a)(1) for failure to timely file; and (5) whether

petitioner is liable for the accuracy-related penalty.

Background

Some of the facts are stipulated and are so found. At the

time the petition in this case was filed, petitioner resided in

Orland Park, Illinois.

Petitioner and Mohammed M. Nahhas (Mr. Nahhas) were married

on July 31, 1980. Three children were born in the marriage, NN,

1

Respondent has determined that petitioner is liable for

alternative minimum tax for her 2002 taxable year. This issue is

computational in nature and will be addressed in a Rule 155

computation.

- 3 -

MN, and MN.2 On or about December 29, 2001, Mr. Nahhas moved out

of the marital residence. In early 2002, petitioner filed a

petition with the Circuit Court of Cook County, Illinois,

Domestic Relations Division (circuit court) to commence divorce

proceedings against Mr. Nahhas.

On April 10, 2002, the circuit court entered a temporary

order for maintenance and support. The order provides, in

pertinent part:

Without prejudice, Mohammed shall pay to Nada as and

for unallocated maintenance & support the amount of

$13200NN/month, payable on 15th and 30th each month,

1st payment 6600 due 4-15-02.

On May 29, 2002, the circuit court entered an agreed order

and stated that the temporary order would remain in effect until

further order of the Court.

On December 24, 2002, the court entered an order amending

the temporary order by reducing the “unallocated maintenance and

support” obligation of Mr. Nahhas from $13,200 per month to

$9,700 per month effective January 1, 2003. The reduction was

based on changes in an affidavit of expenses provided by

petitioner and an affidavit of monthly income provided by Mr.

Nahhas.

On December 15, 2003, the circuit court entered a judgment

for dissolution of marriage between petitioner and Mr. Nahhas.

2

The Court uses only the initials of the minor children.

- 4 -

The judgment provided, in the findings section:

11. The Court finds this is a case that utilizing the

factors in Section 504 for an award of permanent

maintenance is warranted. The Court ordered

unallocated support shall be in the amount of $7,500.00

per month. The payment of unallocated maintenance and

support from the Husband to the wife shall be reviewed

when the youngest child attains the age of 18 years

old. The maintenance portion of unallocated

maintenance and support shall be permanent.

* * * * * * *

Further, the ordered, adjudged, and decreed part of the

order provided:

C. That [Mr. Nahhas] shall pay to [petitioner] the sum

of $7,500.00 per month as and for the unallocated

support of his family. It is the intention of the

Court that such sum shall be taxable to [petitioner]

and deductible by [Mr. Nahhas]. Further the duration

of such award shall be until the minor child reaches 18

years of age. That [Mr. Nahhas] is barred from any

claim for maintenance from [petitioner].

On Line 11 of her Federal income tax return, petitioner

reported income of $105,600 as alimony received but lined out

this figure and reported only $13,715 of Schedule C, Profit or

Loss from Business income.3

Discussion

The Commissioner’s determinations are presumed correct, and

taxpayers generally bear the burden of proving otherwise. Welch

3

Apparently the $105,600 amount represents 8 monthly

payments of $13,200 or 16 bi-monthly payments of $6,600. However

if one uses the Apr. 15, 2002, effective payment date, as

provided by the temporary order, 9 monthly or 18 bimonthly

payments were made in 2002 totaling $118,800.

- 5 -

v. Helvering, 290 U.S. 111, 115 (1933). Petitioner did not

argue that section 7491 is applicable in this case, nor did he

establish that the burden of proof should shift to the

respondent. Moreover, the issues involved in this case (alimony

and the alternative minimum tax) are legal issues and should be

decided on the record without regard to the burden of proof.

Petitioner, however, bears the burden of proving that

respondent’s determination in the notice of deficiency is

erroneous. See Rule 142(a); Welch v. Helvering, supra at 115.

An individual may deduct from his or her gross income the

payments he or she made during a taxable year for alimony or

separate maintenance. Sec. 215(a). Conversely, the recipient of

alimony or separate maintenance payments must include those

payments when calculating his or her gross income. Sec.

61(a)(8).

Section 71(b)(1) defines “alimony or separate maintenance

payment” as any payment in cash if:

(A) such payment is received by (or on behalf of)

a spouse under a divorce or separation instrument,

(B) the divorce or separation instrument does not

designate such payment as a payment which is not

includable in gross income under this section and not

allowable as a deduction under section 215,

(C) in the case of an individual legally separated

from his spouse under a decree of divorce or of

separate maintenance, the payee spouse and the payor

spouse are not members of the same household at the

time such payment is made, and

- 6 -

(D) there is no liability to make any such payment

for any period after the death of the payee spouse and

there is no liability to make any payment (in cash or

property) as a substitute for such payments after the

death of the payee spouse.

The test under section 71(b)(1) is conjunctive; a payment is

deductible as alimony only if all four requirements of section

71(b)(1) are present. See Jaffe v. Commissioner, T.C. Memo.

1999-196.

Section 71(b)(2) defines a “divorce or separation

instrument” as:

(A) a decree of divorce or separate maintenance or

a written instrument incident to such a decree,

(B) a written separation agreement, or

(C) a decree (not described in a subparagraph (A))

requiring a spouse to make payments for the support or

maintenance of the other spouse.

Section 71(c)(1) provides that the general inclusion rule of

section 71(a) for alimony and separate maintenance payments in

gross income does not apply to “any payment which the terms of

the divorce or separation instrument fix (in terms of an amount

of money or a part of the payment) as a sum which is payable for

the support of the children of the payor spouse.”

I. Characterization of Monthly Payments

Petitioner argues that none of the monthly payments she

received in 2002 as “unallocated maintenance and support” from

Mr. Nahhas should be included in her gross income since the

amounts are properly characterized as nontaxable child support.

- 7 -

Respondent disagrees and contends that the payments made in

2002 to petitioner qualified as alimony taxable to petitioner as

the recipient under section 71(b). In particular, respondent

notes that the temporary order did not expressly provide that the

payments were not includable in petitioner’s gross income and not

allowable as a deduction by Mr. Nahhas under section 71(b)(1)(B).

Moreover, respondent points out that the temporary order did not

“fix” any portion of the payment as payable for the support of

the children as required by section 71(c)(1) for child support.

We agree with respondent.

It is clear from the record that the 2002 payments satisfy

the requirements of subparagraphs (A) and (C) of section 71(b).

Petitioner received the payments under the terms of the temporary

order, and petitioner and Mr. Nahhas were not members of the same

household in 2002.

The Court now considers section 71(b)(1)(B), which provides

that a payment will not be alimony if the divorce or separation

instrument designates the payment as not includable in gross

income and not allowable as an alimony deduction. The

designation in the divorce or separation instrument does not need

to specifically refer to section 71 or 215. Estate of Goldman v.

Commissioner, 112 T.C. 317, 323 (1999), affd. without published

opinion sub nom. Schutter v. Commissioner, 242 F.3d 390 (10th

Cir. 2000). The divorce or separation instrument, however, “must

- 8 -

contain a clear, explicit and express direction” that the

payments are not to be treated as alimony. Richardson v.

Commissioner, 125 F.3d 551, 556 (7th Cir. 1997), affg. T.C. Memo.

1995-554.

The Court declines petitioner’s invitation to go beyond the

language of the temporary order. The plain language of section

71(b)(1)(B) provides that when, under the divorce or separation

instrument, the payment by one spouse to the other spouse is not

includable in the gross income of the receiving spouse and is not

allowable as a deduction to the payor spouse, the payments do not

constitute alimony. In this case, the language contained in the

temporary order does not expressly state that the payments are

not includable in petitioner’s gross income and not deductible to

Mr. Nahhas, and section 71(b)(1)(B), therefore, is satisfied.4

Next, the Court considers the requirements of section

71(b)(1)(D), which requires, as a condition to qualify as

alimony, that the obligation to make payments must terminate upon

the death of the former spouse. If the payor is liable for even

one otherwise qualifying payment after the recipient’s death,

none of the related payments required before death will be

alimony. Sec. 1.71-1T(b), Q&A-13, Temporary Income Tax Regs., 49

4

The Court observes that, unlike the temporary order, the

final judgment of dissolution contains express language providing

that the payments would be taxable to petitioner and deductible

by Mr. Nahhas.

- 9 -

Fed. Reg. 34456 (Aug. 31, 1984). Whether such obligation exists

may be determined by the terms of the applicable instrument, or

if the instrument is silent on the matter, by looking to State

law. Morgan v. Commissioner, 309 U.S. 78, 80 (1940); Kean v.

Commissioner, T.C. Memo. 2003-163, affd. 407 f.3d 186 (3d Cir.

2005); Gilbert v. Commissioner, T.C. Memo. 2003-92, affd. sub

nom. Hawley v. Commissioner, 94 Fed. Appx. 126 (3d Cir. 2004).

Thus, to qualify as alimony, the obligation of Mr. Nahhas to make

the payments must terminate at the death of petitioner.

In deciding whether the 2002 payments were alimony, the

Court looks to the language of the temporary order to ascertain

whether it contains a termination upon death condition, and, if

it does not, whether State law supplies such a condition. Hoover

v. Commissioner, 102 F.3d 842, 847 (6th Cir. 1996), affg. T.C.

Memo. 1995-183; see Gonzales v. Commissioner, T.C. Memo. 1999-

332; see also Cunningham v. Commissioner, T.C. Memo. 1994-474.

State law determines certain rights of the parties, and Federal

law determines the Federal income tax consequences of those

rights. Morgan v. Commissioner, supra at 80; Lucas v. Earl, 281

U.S. 111 (1930).

In this instance, the temporary order does not explicitly

order that the payments terminate upon petitioner’s death, and,

thus, the Court looks to Illinois law to determine whether the

- 10 -

payments would terminate by operation of Illinois law. Hoover v.

Commissioner, supra at 847.

Neither party has addressed the application of section

71(b)(1)(D). Further, neither party cites, nor are we aware of,

any Illinois cases addressing the issue of whether, absent an

agreement of the parties or a directive in the divorce decree, an

obligation to pay unallocated maintenance and support terminates

upon the death of the payee spouse.

The Court concludes that the payments qualify as alimony

under section 71(b)(1)(D). Section 510(c) of the Illinois

Dissolution of Marriage Act provides “the obligation to pay

future maintenance is terminated” upon the death, remarriage, or

cohabitation of the recipient “Unless otherwise agreed by the

parties in a written agreement set forth in the judgment or

otherwise approved by the court.” 750 Ill. Comp. Stat. Ann.

5/10(c) (West 1999). Thus, under Illinois law, there is an

automatic termination of the unallocated maintenance portion of

the payments. See id.

Contrary to petitioner’s argument that the payments are

nontaxable child support, the temporary order provided for

monthly or bimonthly payments in the total amount of $13,200 per

month for “unallocated maintenance and support.” The temporary

order does not “contain a clear, explicit and express direction”

that the payments are not includable in petitioner’s gross income

- 11 -

and are not allowable as a deduction to Mr. Nahhas. Richardson

v. Commissioner, supra at 556.

Petitioner argues that the payments were always intended to

be nontaxable child support. To support her contention,

petitioner presented testimony at trial that the dollar amounts

provided for in the temporary order were based on guidelines set

forth under State law for child support. In addition,

petitioner’s attorney during the marital dissolution proceedings

testified at length that he intended that the payments under the

temporary order to be for child support and, hence, nontaxable to

petitioner.5

The Court concludes that the payments do not qualify as

child support under section 71(c)(1).

Thus, petitioner received alimony under the temporary order

in 2002 in the amount of $118,800. ($13,200 per month x 9

months).

II. Interest Income

Generally, gross income means all income from whatever

source derived, including interest income. Sec. 61(a)(4).

During 2002, respondent received information from third-party

payers that petitioner received interest income from three

5

Petitioner’s attorney evidently drafted the temporary

order after a hearing and at the direction of the circuit court.

Upon review, the circuit court adopted the temporary order.

- 12 -

separate bank accounts. The bank accounts and interest income

were:

Harris Bank ARGO $1,201.00

Heritage Community Bank 1,086.00

Citibank F.S.B. 30.00

At trial, petitioner’s attorney during the marital

dissolution proceedings credibly testified that an escrow account

was opened that contained funds from both petitioner and Mr.

Nahhas. Ownership of the funds in the escrow account was

transferred to petitioner in 2003 under the December 15, 2003,

judgment for final dissolution. Petitioner confirmed that the

escrow account was located at the Harris Community Bank.

Petitioner, however, did not address the ownership of either the

Heritage or Citibank bank accounts in 2002.

It is a general rule of taxation that income is not

constructively received if a taxpayer’s control of its receipt is

subject to substantial limitations or restrictions. See sec.

1.451-2(a), Income Tax Regs. Moreover, it is well established

that “gross income” generally refers to assets over which the

taxpayer can exercise “dominion and control.” Ianniello v.

Commissioner, 98 T.C. 165, 173 (1992). Thus, when amounts are

deposited in an escrow account beyond that taxpayer’s reach, they

generally are not includable in his gross income. See, e.g.,

Reed v. Commissioner, 723 F.2d 138 (1st Cir. 1983) (no receipt

- 13 -

where escrow arrangement was bona fide deferred payment agreement

between buyer and seller), revg. T.C. Memo. 1982-734

Based on the record, the Court finds that petitioner

retained an interest in the Heritage and Citibank bank accounts

in 2002, and therefore such income is includable in her gross

income. The Court further finds that the interest income from

the escrow account at the Harris Community Bank is not includable

in petitioner’s gross income for 2002.

III. Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes an addition to tax equal to 5

percent of the amount required to be shown as tax on a return for

each month or fraction thereof past the prescribed due date in

which the return is not filed, not to exceed a total of 25

percent. Generally, the amount of the addition to tax under

section 6651(a)(1) is reduced by the amount of any addition to

tax imposed under section 6651(a)(2) (which relates to failure to

pay the tax shown on a return by the prescribed date) with

respect to each month in which both are otherwise applicable.

Sec. 6651(c)(1).

A taxpayer may avoid the addition to tax under section

6651(a)(1) if he establishes that the failure to file is due to

reasonable cause and not due to willful neglect. “Reasonable

cause” requires the taxpayer to demonstrate that he exercised

ordinary business care and prudence and was nonetheless unable to

- 14 -

file a return within the prescribed time. United States v.

Boyle, 469 U.S. 241, 246 (1985). “[W]illful neglect” means a

conscious, intentional failure or reckless indifference. Id. at

245.

Although respondent bears the burden of production with

respect to this addition to tax, petitioner ultimately bears the

burden of proof. Sec. 7491(c); Rule 142(a); Higbee v.

Commissioner, 116 T.C. 438 (2001).

In the absence of an extension, the last date for petitioner

to file her Federal income tax return for taxable year 2002 was

April 15, 2003. Instead, petitioner filed her 2002 return on May

27, 2003.

Petitioner did not attempt to explain the failure to file

and provided no indication that she had reasonable cause

therefor. Respondent has therefore satisfied his burden of

production by establishing that petitioner filed her return late.

We sustain respondent’s determination that petitioner is liable

for the addition to tax under section 6651(a)(1).

IV. Accuracy-Related Penalty

The last issue for decision is whether petitioner is liable

for an accuracy-related penalty pursuant to section 6662(a) for

the 2002 taxable year. A taxpayer is liable for an accuracy-

related penalty of 20 percent of any part of an underpayment

attributable to negligence or disregard of rules or regulations.

- 15 -

Sec. 6662(a) and (b)(1). The term “negligence” includes any

failure to make a reasonable attempt to comply with the

provisions of the internal revenue laws or to exercise ordinary

and reasonable care in the preparation of a tax return. Sec.

6662(c); Gowni v. Commissioner, T.C. Memo. 2004-154. The term

“disregard” includes any careless, reckless, or intentional

disregard. Sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

The accuracy-related penalty does not apply to any part of

an underpayment for which there was reasonable cause and with

respect to which the taxpayer acted in good faith. Sec.

6664(c)(1); sec. 1.6664-4(a), Income Tax Regs. The determination

of whether a taxpayer acted with reasonable cause and in good

faith is made on a case-by-case basis, taking into account all

pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income

Tax Regs. Generally, the most important factor is the extent of

the taxpayer’s effort to assess the taxpayer’s proper tax

liability. Id. Here, the income tax return in question was

prepared by someone from Abbasi Accounting and Tax Services. We

note that on line 11 of the income tax return for reporting

“Alimony received” the amount of $105,600 originally reported was

lined-out. As previously noted this amount represents $13,200

received for 8 months in 2002. Petitioner reported only $13,915

of Schedule C income. Evidently, either the tax return preparer

- 16 -

or petitioner recognized that the payments petitioner received

could be alimony.

Section 7491(c) places on the Commissioner the burden of

producing evidence showing that it is appropriate to impose any

penalty or addition to tax. Once the Commissioner meets that

burden, the taxpayer must produce evidence sufficient to show

that Commissioner’s determination is incorrect. Higbee v.

Commissioner, supra at 447. The Commissioner need not produce

evidence relating to defenses such as reasonable cause. Id. at

446.

Petitioner does not contest receiving the 2002 payments from

Mr. Nahhas. Petitioner’s position that the amounts were

nontaxable child support clearly conflicts with the designation

of the payments as “unallocated maintenance and support” in the

temporary order. Petitioner also did not report interest income

received from the Heritage and Citibank bank accounts.

Accordingly, we conclude that respondent has met his burden of

production for the ground of negligence by showing that

petitioner failed to exercise ordinary and reasonable care in

preparing her 2002 tax return. See sec. 6662(c); Gowni v.

Commissioner, supra.

With respect to the inclusion of the 2002 payments in her

gross income, petitioner testified that she relied on the

representation made by the attorney who represented her in the

- 17 -

marital dissolution proceeding that the amounts were not taxable.

Reliance on an attorney may relieve a taxpayer from the accuracy-

related penalty where the taxpayer’s reliance is reasonable.

Stolz v. Commissioner, T.C. Memo. 1999-404. However, in this

case, petitioner’s attorney did not draft the temporary order to

provide that the amount for support or temporary maintenance was

not includable in her income, and therefore, these facts do not

support reasonable cause. Petitioner’s reliance on the divorce

attorney also does not constitute reasonable cause, as she failed

to show that the attorney was skilled or knowledgeable in the tax

consequences of the divorce proceeding. Therefore, we sustain

respondent’s determination of the penalty under section 6662(a)

and (b)(1) for taxable year 2002.

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

under Rule 155.